##### Table of Contents



UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
 Washington D.C 20549
 
 Form 10-Q
 þ
    
    QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
 For the quarterly period ended June 30, 2005
 or
 o
    
    TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
OF 1934
 Commission File Numbers 333-97293 and 333-116927
 EXTENDICARE HEALTH SERVICES, INC.
 (Exact name of registrant as specified in its charter)
 Delaware
    
    111 West Michigan Street
    
    98-0066268(State or other jurisdiction of
    
    Milwaukee, WI 53203
    
    (I.R.S. Employerincorporation or organization)
    
    (Address of principal executive office
    
    Identification Number)including zip code)
 (414) 908-8000
  þ o
  o þ




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EXTENDICARE HEALTH SERVICES, INC.
  
 INDEX
 PagePart I Financial Information:Item 1 Financial Statements:Condensed Consolidated Statements of Income for the Three Months and Six Months Ended
June 30, 2005 and 2004
    
    
    3Condensed Consolidated Balance Sheets, June 30, 2005 and December 31, 2004
    
    
    4Condensed Consolidated Statements of Cash Flows for the Six Months Ended
June 30, 2005 and 2004
    
    
    5Notes to Condensed Consolidated Financial Statements
    
    
    7Item 2 Managements Discussion and Analysis of Financial Condition and Results of Operations
    
    
    28Item 3 Quantitative and Qualitative Disclosures About Market Risk
    
    
    63Item 4 Controls and Procedures
    
    
    64Part II Other Information:Item 1 Legal Proceedings
    
    
    65Item 6 Exhibits
    
    
    65Signatures
    
    
    66Exhibit Index
    
    
    67CertificationCertificationCertification
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PART I
FINANCIAL INFORMATION
 
 Item 1. Financial Statements
 EXTENDICARE HEALTH SERVICES, INC.
 
 CONDENSED CONSOLIDATED STATEMENTS OF INCOME
FOR THE THREE MONTHS AND SIX MONTHS ENDED JUNE 30, 2005 AND 2004
(In thousands)
 Three Months Ended June 30,
    
    Six Months Ended June 30,2005
    
    2004
    
    2005
    
    2004REVENUES:Nursing and assisted living facilities
    
    $
    304,451
    
    
    $
    225,660
    
    
    $
    590,808
    
    
    $
    450,086Outpatient therapy
    
    
    2,903
    
    
    
    3,009
    
    
    
    5,630
    
    
    
    5,674Other
    
    
    4,994
    
    
    
    4,659
    
    
    
    10,057
    
    
    
    9,069312,348
    
    
    
    233,328
    
    
    
    606,495
    
    
    
    464,829COSTS AND EXPENSES (INCOME):Operating
    
    
    243,312
    
    
    
    190,599
    
    
    
    483,739
    
    
    
    380,055General and administrative
    
    
    10,128
    
    
    
    7,333
    
    
    
    19,737
    
    
    
    14,823Lease costs
    
    
    5,784
    
    
    
    2,229
    
    
    
    10,392
    
    
    
    4,493Depreciation and amortization
    
    
    12,267
    
    
    
    8,831
    
    
    
    22,607
    
    
    
    17,512Interest expense, net
    
    
    9,868
    
    
    
    4,384
    
    
    
    18,012
    
    
    
    10,969Valuation adjustment on interest rate caps
    
    
    939
    
    
    
    4,320
    
    
    
    2,237
    
    
    
    4,393Loss (gain) on disposal of assets and
impairment of long-lived assets
    
    
    5,070
    
    
    
    (4,469
    )
    
    
    4,622
    
    
    
    (2,857
    )Loss on refinancing and retirement of debt
    
    
    
    
    
    
    5,978
    
    
    
    275
    
    
    
    6,332287,368
    
    
    
    219,205
    
    
    
    561,621
    
    
    
    435,720INCOME BEFORE INCOME TAXES
    
    
    24,980
    
    
    
    14,123
    
    
    
    44,874
    
    
    
    29,109Income tax expense
    
    
    9,681
    
    
    
    5,297
    
    
    
    17,521
    
    
    
    10,936NET INCOME
    
    $
    15,299
    
    
    $
    8,826
    
    
    $
    27,353
    
    
    $
    18,173
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EXTENDICARE HEALTH SERVICES, INC.
 
 CONDENSED CONSOLIDATED BALANCE SHEETS
JUNE 30, 2005 AND DECEMBER 31, 2004
(In thousands except share data)
 June 30,
    
    December 31,2005
    
    2004ASSETSCurrent Assets:Cash and cash equivalents
    
    $
    9,929
    
    
    $
    29,612Accounts receivable, less allowances of $12,648 and
$10,594, respectively
    
    
    126,894
    
    
    
    95,973Supplies, inventories and other current assets
    
    
    21,567
    
    
    
    17,751Income taxes receivable
    
    
    
    
    
    
    1,654Deferred state income taxes
    
    
    2,947
    
    
    
    2,664Due from shareholder and affiliates:Federal income taxes receivable
    
    
    7,062
    
    
    
    5,231Deferred federal income taxes
    
    
    14,600
    
    
    
    13,258Other
    
    
    
    
    
    
    7,690Total current assets
    
    
    182,999
    
    
    
    173,833Property and equipment, net
    
    
    746,665
    
    
    
    446,085Goodwill and other intangible assets, net
    
    
    82,846
    
    
    
    74,554Deferred state income taxes
    
    
    2,830
    
    
    
    Other assets
    
    
    42,284
    
    
    
    41,485Total Assets
    
    $
    1,057,624
    
    
    $
    735,957LIABILITIES AND SHAREHOLDERS EQUITYCurrent Liabilities:Current maturities of long-term debt
    
    $
    5,307
    
    
    $
    1,071Accounts payable
    
    
    20,974
    
    
    
    22,297Accrued liabilities
    
    
    133,991
    
    
    
    99,920Current portion of accrual for self-insured liabilities
    
    
    12,500
    
    
    
    18,000Current portion of amounts due to shareholder and affiliates
    
    
    2,974
    
    
    
    2,975Income taxes payable
    
    
    961
    
    
    
    Total current liabilities
    
    
    176,707
    
    
    
    144,263Accrual for self-insured liabilities
    
    
    22,956
    
    
    
    19,725Long-term debt and capital lease obligations
    
    
    549,382
    
    
    
    290,861Deferred state income taxes
    
    
    
    
    
    
    1,833Other long-term liabilities
    
    
    19,204
    
    
    
    12,448Due to shareholder and affiliates:Deferred federal income taxes
    
    
    6,914
    
    
    
    1,853Other
    
    
    4,979
    
    
    
    14,785Total Liabilities
    
    
    780,142
    
    
    
    485,768Shareholders Equity:Common stock, $1 par value, 1,000 shares
authorized, 947 shares issued and outstanding
    
    
    1
    
    
    
    1Additional paid-in capital
    
    
    209,503
    
    
    
    209,221Accumulated other comprehensive income
    
    
    
    
    
    
    342Retained earnings
    
    
    67,978
    
    
    
    40,625Total Shareholders Equity
    
    
    277,482
    
    
    
    250,189Total Liabilities and Shareholders Equity
    
    $
    1,057,624
    
    
    $
    735,957
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EXTENDICARE HEALTH SERVICES, INC.
 
 CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE SIX MONTHS ENDED JUNE 30, 2005 AND 2004
(In thousands)
 Six Months Ended
    
    Six Months EndedJune 30, 2005
    
    June 30, 2004OPERATING ACTIVITIES:Net income
    
    $
    27,353
    
    
    $
    18,173Adjustments to reconcile net income to net cash
provided by operating activities:Depreciation and amortization
    
    
    22,607
    
    
    
    17,512Amortization of deferred financing costs
    
    
    925
    
    
    
    839Amortization of purchase accounting adjustments for leases and debt
    
    
    (251
    )
    
    
    Amortization of purchase accounting adjustments for below market
resident leases
    
    
    (1,165
    )
    
    
    Provision for self-insured liabilities
    
    
    4,037
    
    
    
    3,300Payment of self-insured liability claims
    
    
    (7,209
    )
    
    
    (4,897
    )Deferred income taxes
    
    
    3,497
    
    
    
    (9,494
    )Valuation adjustment on interest rate caps
    
    
    2,237
    
    
    
    4,393Loss (gain) on disposal of assets and impairment of long-lived assets
    
    
    4,622
    
    
    
    (2,857
    )Loss on refinancing and retirement of debt
    
    
    275
    
    
    
    6,332Changes in assets and liabilities:Accounts receivable attributable to Indiana and Pennsylvania provider tax
    
    
    (17,618
    )
    
    
    Accounts receivable
    
    
    (10,207
    )
    
    
    (2,513
    )Other assets
    
    
    573
    
    
    
    10,538Supplies, inventories and other current assets
    
    
    2,951
    
    
    
    (1,056
    )Accounts payable
    
    
    (4,153
    )
    
    
    (2,950
    )Accrued liabilities attributable to Indiana and Pennsylvania provider tax
    
    
    10,904
    
    
    
    Accrued liabilities
    
    
    5,632
    
    
    
    5,662Income taxes payable/receivable
    
    
    1,135
    
    
    
    (166
    )Current due to shareholder and affiliates
    
    
    5,204
    
    
    
    8,823Cash provided by operating activities
    
    
    51,349
    
    
    
    51,639INVESTING ACTIVITIES:Payment for acquisition of Assisted Living Concepts, Inc (ALC)
    
    
    (144,316
    )
    
    
    Cash balances in ALC as of acquisition
    
    
    6,547
    
    
    
    Payments for other acquisitions
    
    
    (8,218
    )
    
    
    (6,454
    )Payments for new construction projects
    
    
    (13,106
    )
    
    
    (6,943
    )Payments for purchases of property and equipment
    
    
    (11,437
    )
    
    
    (11,747
    )Proceeds from repayment of notes receivable
    
    
    
    
    
    
    20,552Proceeds from completion of divestiture agreement
    
    
    
    
    
    
    10,000Proceeds from sales of investments
    
    
    976
    
    
    
    4,894Proceeds from sale of property and equipment
    
    
    1,878
    
    
    
    Changes in other non-current assets
    
    
    (862
    )
    
    
    (229
    )Cash provided by (used in) investing activities
    
    
    (168,538
    )
    
    
    10,073FINANCING ACTIVITIES:Proceeds from Revolving Credit Facility to finance ALC acquisition
    
    
    60,000
    
    
    
    Proceeds from 6% EHI Term Note to finance ALC acquisition
    
    
    55,000
    
    
    
    Payments of long-term debt
    
    
    (20,350
    )
    
    
    (219,188
    )Payments on line of credit
    
    
    (8,000
    )
    
    
    Proceeds from issuance of long-term debt
    
    
    10,000
    
    
    
    128,082Payment of deferred financing costs
    
    
    (125
    )
    
    
    (5,306
    )Payment of interest rate cap fee
    
    
    
    
    
    
    (3,495
    )Payment of tender and call premium and legal expenses
    
    
    
    
    
    
    (6,921
    )Proceeds from termination of interest rate swap and cap
    
    
    
    
    
    
    2,615Advances from shareholder and an affiliate
    
    
    
    
    
    
    22,900Other long-term liabilities
    
    
    981
    
    
    
    217Cash provided by (used in) financing activities
    
    
    97,506
    
    
    
    (81,096
    )Decrease in cash and cash equivalents
    
    
    (19,683
    )
    
    
    (19,384
    )Cash and cash equivalents, beginning of period
    
    
    29,612
    
    
    
    48,855Cash and cash equivalents, end of period
    
    $
    9,929
    
    
    $
    29,471
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EXTENDICARE HEALTH SERVICES, INC.
 CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (Continued)
FOR THE SIX MONTHS ENDED JUNE 30, 2005 AND 2004
(In thousands)
 Six Months Ended
    
    Six Months EndedJune 30, 2005
    
    June 30, 2004Supplemental schedule of cash flow information:Cash paid during the period for:Interest
    
    $
    16,455
    
    
    $
    10,235Income tax payments, net of refunds
    
    
    14,581
    
    
    
    2,921Supplemental schedule of non-cash investing
and financing activities:The Company
acquired all of the capital stock of Assisted Living Concepts, Inc.
for $144,316. In connection with the acquisition, liabilities were
assumed as follows:Fair value of assets acquired
    
    $
    316,984
    
    
    $
    Cash paid
    
    
    (144,316
    )
    
    
    Liabilities assumed
    
    $
    172,668
    
    
    $
    Capital lease obligations incurred to
purchase properties  See Notes 7 and 9
    
    $
    12,822
    
    
    $
    
  6




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EXTENDICARE HEALTH SERVICES, INC.
 
 NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 1. Summary of Significant Accounting Policies
  Basis of Presentation
     2. New Accounting Policies
   7




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3. New Accounting Pronouncements
   8




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4. Acquisition of Assisted Living Concepts, Inc.
   (in thousands)ASSETS:Cash, net of cash used to finance the acquisition
    
    $
    (22,652
    )Accounts receivable
    
    
    3,003Other current assets
    
    
    8,308Total current assets
    
    
    (11,341
    )Property, plant and equipment
    
    
    284,223Resident relationships intangible
    
    
    6,357Goodwill
    
    
    2,529Other long-term assets
    
    
    6,016Total assets
    
    $
    287,784LIABILITIES:Current maturities of long-term debt
    
    $
    3,418Other current liabilities
    
    
    19,850Total current liabilities
    
    
    23,268Long-term debt:Long-term debt of ALC assumed
    
    
    141,046Proceeds from 6% from EHI Term Loan to finance acquisition
    
    
    55,000Proceeds from revolving credit facility to finance acquisition
    
    
    60,000Total long-term debt
    
    
    256,046Other long term liabilities
    
    
    8,470Total liabilities
    
    $
    287,784
   9




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Three Months
    
    Six MonthsEnded June 30,
    
    Ended June 30,2005
    
    2004
    
    2005
    
    2004(in thousands)Total revenues
    
    $
    312,348
    
    
    $
    277,029
    
    
    $
    621,605
    
    
    $
    552,484Income before income taxes
    
    
    24,980
    
    
    
    14,461
    
    
    
    44,060
    
    
    
    29,893Net income
    
    
    15,299
    
    
    
    9,824
    
    
    
    26,858
    
    
    
    19,897
   10




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5. Other Acquisitions and New Construction
  (in thousands)Cash used to finance the acquisition
    
    $
    (8,219
    )Other current assets
    
    
    (4
    )Total current assets
    
    
    (8,223
    )Property, plant and equipment
    
    
    7,360Goodwill and other intangible assets
    
    
    863Total assets
    
    $
    
    6. Approval of Indiana, Pennsylvania and Washington State Plans and Amendments Relating to
Medicaid Revenues
   11




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7. Property and Equipment, Net
  Six Months Ended2005
    
    2004(in thousands)Balance at beginning of period
    
    $
    446,085
    
    
    $
    448,743Properties and equipment acquired in
acquisition of ALC
    
    
    284,223
    
    
    
    Other acquisitions
    
    
    7,360
    
    
    
    5,898Properties acquired under capital leases
 see Note 9
    
    
    12,822
    
    
    
    Purchases of properties and equipment
    
    
    11,437
    
    
    
    11,747Payments for new constructions projects
    
    
    13,106
    
    
    
    6,943Depreciation and amortization
    
    
    (21,156
    )
    
    
    (16,944
    )Impairment of long-lived assets
    
    
    (5,700
    )
    
    
    (1,362
    )Disposals and other
    
    
    (1,512
    )
    
    
    (7
    )Balance at end of period
    
    $
    746,665
    
    
    $
    455,018
 8. Other Assets
  June 30,
    
    December 31,2005
    
    2004(in thousands)Deferred financing costs, net
    
    $
    10,896
    
    
    $
    11,828Non-current accounts receivable from Medicare and Medicaid
programs
    
    
    9,641
    
    
    
    10,214Non-current accounts receivable from non-affiliated long-term
care operators
    
    
    10,445
    
    
    
    9,469Indemnification escrow
    
    
    3,700
    
    
    
    3,700Funds held under deferred compensation plan
    
    
    2,041
    
    
    
    2,001Debt service and capital expenditure trust funds
    
    
    2,146
    
    
    
    309Cash held by bank as collateral for ALC letters of credit
    
    
    1,019
    
    
    
    Prepaid interest rate cap fee
    
    
    284
    
    
    
    984Other
    
    
    2,112
    
    
    
    2,980$
    42,284
    
    
    $
    41,485
 Medicare and Medicaid Settlement Receivables
  June 30,
    
    December 31,2005
    
    2004(in thousands)Total settlement receivables from Medicare and
Medicaid programs, less contractual allowance of
$4,370
    
    $
    15,634
    
    
    $
    16,954Less: Current portion of Medicare and Medicaid
settlement receivables (included in accounts
receivable)
    
    
    5,993
    
    
    
    6,740Non-current portion of Settlement Accounts Receivable
    
    $
    9,641
    
    
    $
    10,214
 12




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Advances and Amounts Due from Non-Affiliated Long-term Care Operators
    13




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9. Line of Credit and Long-term Debt
 Summary of Long-term Debt
  June 30,
    
    December 312005
    
    2004(in thousands)9.50% Senior Notes due 2010
    
    $
    149,734
    
    
    $
    149,7146.875% Senior Subordinated Notes due 2014
    
    
    122,137
    
    
    
    122,022Revolving Credit Facility due 2009, at variable interest rates
    
    
    62,000
    
    
    
    6.00% EHI Term Note due 2010
    
    
    55,000
    
    
    
    6.24% Red Mortgage Capital Note due 2014
    
    
    36,858
    
    
    
    GE Capital Term Loan and Credit Facility, at variable interest rates, due 2009
    
    
    35,272
    
    
    
    DMG Mortgage notes payable, interest rates ranging from 7.58% to 8.65%, due
2008
    
    
    27,816
    
    
    
    Revenue Bonds, at variable interest rates, maturing through 2018
    
    
    21,995
    
    
    
    Capital lease obligations, interest rates ranging from 2.84% to 13.54%,
maturing through 2009
    
    
    12,397
    
    
    
    11Oregon Trust Deed Notes, interest rates ranging from 0.25% to 10.90%,
maturing from 2020 through 2026
    
    
    9,714
    
    
    
    HUD Insured Mortgages, interest rates ranging from 7.40% to 7.55%, due 2036
    
    
    7,709
    
    
    
    6.00% EI Term Note due 2010
    
    
    8,900
    
    
    
    Other mortgage notes payable, interest rates ranging from 3.0% to 7.25%,
maturing through 2009
    
    
    4,202
    
    
    
    9,730Industrial Development Revenue Bond due 2014
    
    
    
    
    
    
    9,5006.25% Industrial Development Revenue Bond, maturing 2008
    
    
    955
    
    
    
    955Long-term debt before current maturities
    
    
    554,689
    
    
    
    291,932Less current maturities
    
    
    5,307
    
    
    
    1,071Total long-term debt
    
    $
    549,382
    
    
    $
    290,861
  Revolving Credit Facility
   14




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6.0% EHI Term Note due 2010
  6.24% Red Mortgage Capital Note due 2014
  GE Capital Term Loan and Credit Facility due 2009
   DMG Mortgage Notes Payable due 2008
  15




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Revenue Bonds
    Capital Lease Obligations
  Oregon Trust Deed Notes
   16




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HUD Insured Mortgages due 2036
  6.0% EI Term Note due 2010
  Mortgage Notes Payable
  Industrial Development Revenue Bond due 2014
  10. Accounting for Derivative Instruments and Hedging Activities
 Objectives and Strategies
   Interest Rate Swap and Cap Agreements Entered into in April 2004 and Maturing in 2010 and 2014
   17




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Quantitative Disclosures
    18




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11. Due to Shareholder and Affiliate
  June 30,
    
    December 31,Affiliate
    
    Purpose
    
    2005
    
    2004(in thousands)Receivable (payable)Current assets:Extendicare Holdings, Inc.
    
    Federal income taxes receivable
    
    $
    7,062
    
    
    $
    5,231Extendicare Holdings, Inc.
    
    Deferred federal income taxes
    
    
    14,600
    
    
    
    13,258Extendicare Inc.
    
    Working capital advances
    
    
    
    
    
    
    7,69021,662
    
    
    
    26,179Current liabilities:Virtual Care Provider, Inc.
    
    Working capital advances
    
    
    (3,000
    )
    
    
    (3,000
    )The Northern Group, Inc.
    
    Intercompany operating expenses
    
    
    17
    
    
    
    19Laurier Indemnity Company, Ltd.
    
    Intercompany insurance premium
    
    
    6
    
    
    
    3Extendicare Holdings, Inc.
    
    Working capital advances
    
    
    3
    
    
    
    3(2,974
    )
    
    
    (2,975
    )Long-term liabilities:Extendicare Holdings, Inc.
    
    Deferred federal income taxes
    
    
    (6,914
    )
    
    
    (1,853
    )Other:Extendicare Inc.
    
    Advances
    
    
    
    
    
    
    (8,900
    )Extendicare Inc.
    
    Advances
    
    
    2,300
    
    
    
    1,218Extendicare Holdings, Inc.
    
    Advances
    
    
    (3,483
    )
    
    
    (3,483
    )Virtual Care Provider, Inc.
    
    Advances
    
    
    (3,796
    )
    
    
    (3,620
    )(4,979
    )
    
    
    (14,785
    )$
    6,795
    
    
    $
    6,566
  12. Loss (Gain) on Disposal of Assets and Impairment of Long-lived Assets
  Three Months Ended June 30,
    
    Six Months Ended June 30,2005
    
    2004
    
    2005
    
    2004(in thousands)Impairment of Lakeside nursing
facility in Wisconsin
    
    $
    5,700
    
    
    $
    
    
    
    $
    5,700
    
    
    $
    Gain on sale of MetLife common shares
    
    
    (630
    )
    
    
    
    
    
    
    (630
    )
    
    $
    Gain on sale of Maryland property
    
    
    
    
    
    
    
    
    
    
    (448
    )
    
    
    Completion of Divestiture Agreement with
Greystone
    
    
    
    
    
    
    (4,872
    )
    
    
    
    
    
    
    (4,872
    )Loss on repayment of notes due from Tandem
    
    
    
    
    
    
    1,266
    
    
    
    
    
    
    
    1,266Gain on sale of Omnicare shares to
Extendicare
    
    
    
    
    
    
    (863
    )
    
    
    
    
    
    
    (863
    )Impairment of nursing facility in Indiana
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1,612$
    5,070
    
    
    $
    (4,469
    )
    
    $
    4,622
    
    
    $
    (2,857
    )
 19




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##### Table of Contents



Medicare, Medicaid
    
    Resident andand Supplier
    
    EmployeeClaims
    
    Claims
    
    Other
    
    Total(in thousands)Balance December 31, 2003
    
    $
    6,637
    
    
    $
    494
    
    
    $
    160
    
    
    $
    7,291Provisions (charges) (1)
    
    
    (3,198
    )
    
    
    
    
    
    
    
    
    
    
    (3,198
    )Cash Payments
    
    
    (1,410
    )
    
    
    
    
    
    
    (160
    )
    
    
    (1,570
    )Balance December 31, 2004
    
    
    2,029
    
    
    
    494
    
    
    
    
    
    
    
    2,523Cash Payments
    
    
    (963
    )
    
    
    
    
    
    
    
    
    
    
    (963
    )Balance June 30, 2005
    
    $
    1,066
    
    
    $
    494
    
    
    $
    
    
    
    $
    1,560
 
 (1)
    
    Provisions (charges) for 2004 include a $3.2 million write-off of previously
accrued Medicare claims receivable relating to discontinued operations. 20




---



##### Table of Contents



13. Loss on Refinancing and Retirement of Debt
  Three Months
    
    Six MonthsEnded June 30,
    
    Ended June 30,2005
    
    2004
    
    2005
    
    2004(in thousands)Loss on early retirement of Mortgage Note (note 9)
    
    $
    
    
    
    $
    
    
    
    $
    140
    
    
    $
    Loss on early retirement of 2007 Notes
    
    
    
    
    
    
    9,280
    
    
    
    
    
    
    
    9,280Loss on early retirement of Industrial
Development Revenue Bond (note 9)
    
    
    
    
    
    
    
    
    
    
    135
    
    
    
    354Gain on termination of interest rate swap and
cap
    
    
    
    
    
    
    (3,302
    )
    
    
    
    
    
    
    (3,302
    )$
    
    
    
    $
    5,978
    
    
    $
    275
    
    
    $
    6,332
 14. Interest expense, net
  Three Months
    
    Six MonthsEnded June 30,
    
    Ended June 30,2005
    
    2004
    
    2005
    
    2004(in thousands)Interest expense
    
    $
    10,179
    
    
    $
    6,658
    
    
    $
    18,736
    
    
    $
    14,858Interest income
    
    
    (311
    )
    
    
    (2,274
    )
    
    
    (724
    )
    
    
    (3,889
    )$
    9,868
    
    
    $
    4,384
    
    
    $
    18,012
    
    
    $
    10,969
 15. Lease Commitments
  Operating
    
    CapitalLeases
    
    Leases
    
    Total(in thousands)Year Ended December 31:2005
    
    $
    10,744
    
    
    $
    567
    
    
    $
    11,3112006
    
    
    18,586
    
    
    
    1,156
    
    
    
    19,7422007
    
    
    16,651
    
    
    
    1,185
    
    
    
    17,8362008
    
    
    16,886
    
    
    
    1,215
    
    
    
    18,1012009
    
    
    16,881
    
    
    
    11,557
    
    
    
    28,438After 2009
    
    
    82,439
    
    
    
    
    
    
    
    82,439Total minimum payments
    
    
    162,187
    
    
    
    15,680
    
    
    
    177,867Less imputed interest
    
    
    
    
    
    
    3,283
    
    
    
    3,283Net minimum lease payments
    
    $
    162,187
    
    
    $
    12,397
    
    
    $
    174,584
 21




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##### Table of Contents



16. Other Commitments and Contingencies
 Capital Expenditures
   Insurance and Self-insured Liabilities
  Litigation
   22




---



##### Table of Contents



Regulatory Risks
   Cash Flow Commitment to Lakeside Health
   Omnicare Preferred Provider Agreement
   23




---



##### Table of Contents



17. Uncertainties and Certain Significant Risks
 Revenues
   Interests in Unrelated Long-Term Care Providers
  Accrual for Self-Insured Liabilities
  24




---



##### Table of Contents



18. Comprehensive Income
  Three Months
    
    Three Months
    
    Six Months
    
    Six MonthsEnded
    
    Ended
    
    Ended
    
    EndedJune 30, 2005
    

June 30, 2004
    

June 30, 2005
    
    June 30, 2004(in thousands)NET INCOME
    
    $
    15,299
    
    
    $
    8,826
    
    
    $
    27,353
    
    
    $
    18,173OTHER COMPREHENSIVE INCOME (LOSS):Unrealized
gain (loss) on investments, before tax
    
    
    (538
    )
    
    
    (3,089
    )
    
    
    (570
    )
    
    
    (2,131
    )Gain on cash flow hedges, before tax
    
    
    
    
    
    
    100
    
    
    
    
    
    
    
    167Other comprehensive income (loss), before tax
    
    
    (538
    )
    
    
    (2,989
    )
    
    
    (570
    )
    
    
    (1,964
    )Income tax benefit (provision) related to items of
other comprehensive income
    
    
    215
    
    
    
    1,196
    
    
    
    228
    
    
    
    786Other comprehensive income (loss), net of tax
    
    
    (323
    )
    
    
    (1,793
    )
    
    
    (342
    )
    
    
    (1,178
    )COMPREHENSIVE INCOME
    
    $
    14,976
    
    
    $
    7,033
    
    
    $
    27,011
    
    
    $
    16,995
 19. Subsequent Events
 Medicare Revenues
  Amended and Restated Credit Facility
  
    
    the credit extended to the Company under the Amended and Restated Credit Facility
includes a term loan for $86.0 million; The principal balance of the term loan is payable
in equal quarterly installments of $215,000 over the first four years of the Amended and
Restated Credit Facility, equal quarterly installments of $20.6 million over the first three
quarters of the last year of the Amended and Restated Credit Facility, and a final principal
installment of $20.6 million due on the maturity date.
    
    the revolving credit limit under the Amended and Restated Credit Facility reflects a
reduction by $41.0 million from the $155.0 million limit under the Revolving Credit Facility
to $114.0 million under the Amended and Restated Credit Facility. Upon notice and at the
option of the participating lenders, the Company may increase the credit extended or
available under the Amended and Restated Credit Facility by up to $15.0 million. The
increase may be in the form of additional term loans or in the form of an increase in the
revolving credit limit.
    
    the maturity date of the Amended and Restated Credit Facility is July 31, 2010,
reflecting an extension of more than one year from the maturity date of the Revolving Credit
Facility.
 25




---



##### Table of Contents




    
    the interest rate spreads over the Eurodollar rate or the base rate, as applicable,
have been reduced and fixed at 1.75% per annum for Eurodollar rate loans and 0.75% per annum
for base rate loans. Under the Revolving Credit Facility the interest rate spread ranged
from 2.50% per annum to 3.25% per annum for Eurodollar rate loans and from 1.50% per annum
to 2.25% per annum for base rate loans, subject, in each case, to adjustments based on the
Companys senior leverage ratio.
    
    the Amended and Restated Credit Facility includes a $10.0 million swing line
commitment within the $114 million revolving credit limit.
    
    the financial covenants under the Amended and Restated Credit Facility include ALCs
debt and earnings, whereas the financial covenants under the Revolving Credit Facility did
not. The financial covenants are otherwise substantially the same as under the Revolving
Credit Facility;
    
    the Amended and Restated Credit Facility includes procedures for ALC and its
subsidiaries to be designated as restricted subsidiaries and guarantors of the Amended and
Restated Credit Facility over time. As this occurs, these subsidiaries will become subject
to the covenants of the Amended and Restated Credit Facility that apply to the Companys
restricted subsidiaries. Also, the Company is permitted to make investments in these
subsidiaries to the same extent that it is permitted to make investments in its other
restricted subsidiaries that have guaranteed the Amended and Restated Credit Facility.
    
    the Amended and Restated Credit Facility increases the Companys ability to make
investments in unrestricted subsidiaries (the unrestricted subsidiaries being ALC and its
subsidiaries unless and until they have been designated as restricted subsidiaries) such
that the Company and its restricted subsidiaries may have investments in unrestricted
subsidiaries outstanding from time to time up to the sum of the amount of investments in
unrestricted subsidiaries at June 30, 2005 plus $40 million.
    
    the Amended and Restated Credit Facility requires that ALCs debt in connection with
the $22.0 million of Revenue Bonds secured by ALC facilities located in the States of
Washington, Idaho and Ohio be repaid in full within 180 days after the closing of the
Amended and Restated Credit Facility. When that repayment occurs, ALC will become a
restricted subsidiary under the Amended and Restated Credit Facility.
    
    the Amended and Restated Credit Facility increases the Companys ability to make
restricted payments to permit annual dividends up to the lesser of (i) 50% of net income, or
(ii) $25 million plus the unused restricted payment amount for the previous fiscal year, or
(iii) $50 million.
 26




---



##### Table of Contents



New Developments
  27




---



##### Table of Contents



Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations
  Forward-Looking Statements
  
    
    Medicare and Medicaid payment levels and reimbursement methodologies and the application
of such methodologies and policies adopted by the government and its fiscal intermediaries;
    
    liabilities and claims asserted against us, such as resident care litigation, including
our exposure for punitive damage claims and increased insurance costs;
    
    national and local economic conditions, including their effect on the ability to hire and
retain qualified staff and employees and the associated costs;
    
    federal and state regulation of our business and change in such regulations, as well as
our compliance with such regulations;
    
    actions by our competitors;
    
    our ability to maintain and increase census levels; and
    
    the successful integration of Assisted Living Concepts, Inc. within our operations.
  28




---



##### Table of Contents



Executive Overview
  
    
    provide quality, clinically-based services;
    
    strengthen both Medicare and total average daily census, or ADC;
    
    improve operating cash flow;
    
    expand our asset portfolio through acquisition or internal growth, and actively manage
our asset portfolio, including where appropriate, divesting facilities that fail to meet our
performance goals;
    
    expand non-government based revenue sources, thereby decreasing the level of risk and
reliance on government funding;
    
    diversify within the long-term care industry through growth of facilities under full
management or selected consulting agreements and rehabilitation clinics; and
    
    increase our operating efficiency.
   Revenues
  29




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##### Table of Contents



Nursing and Assisted Living Facilities.
 Percentage of Total Nursing and Assisted Living RevenuesFor Three Months Ended June 30,
    
    For Six Months Ended June 30,2005
    
    2004
    
    2005
    
    2004Medicare
    
    
    28.5
    %
    
    
    30.8
    %
    
    
    29.5
    %
    
    
    31.1
    %Private and other
    
    
    27.3
    %
    
    
    21.0
    %
    
    
    26.0
    %
    
    
    21.1
    %Quality mix
    
    
    55.8
    %
    
    
    51.8
    %
    
    
    55.5
    %
    
    
    52.2
    %Medicaid
    
    
    44.2
    %
    
    
    48.2
    %
    
    
    44.5
    %
    
    
    47.8
    %Total
    
    
    100.0
    %
    
    
    100.0
    %
    
    
    100.0
    %
    
    
    100.0
    %
  Nursing Facilities.
 Percentage of Total Nursing RevenuesFor Three Months Ended June 30,
    
    For Six Months Ended June 30,2005
    
    2004
    
    2005
    
    2004Medicare
    
    
    35.3
    %
    
    
    32.1
    %
    
    
    35.5
    %
    
    
    32.5
    %Private and other
    
    
    15.1
    %
    
    
    17.8
    %
    
    
    15.3
    %
    
    
    17.9
    %Quality mix
    
    
    50.4
    %
    
    
    49.9
    %
    
    
    50.8
    %
    
    
    50.4
    %Medicaid
    
    
    49.6
    %
    
    
    50.1
    %
    
    
    49.2
    %
    
    
    49.6
    %Total
    
    
    100.0
    %
    
    
    100.0
    %
    
    
    100.0
    %
    
    
    100.0
    %
 Assisted Living Facilities.
 Percentage of Total Assisted Living RevenuesFor Three Months Ended June 30,
    
    For Six Months Ended June 30,2005
    
    2004
    
    2005
    
    2004Private and other
    
    
    78.4
    %
    
    
    92.1
    %
    
    
    78.5
    %
    
    
    92.3
    %Medicaid
    
    
    21.6
    %
    
    
    7.9
    %
    
    
    21.5
    %
    
    
    7.7
    %Total
    
    
    100.0
    %
    
    
    100.0
    %
    
    
    100.0
    %
    
    
    100.0
    %
  Other Revenues.
 30




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##### Table of Contents



Legislative Actions Affecting Revenues
 Future Medicare Changes.
   Regulatory Environment Affecting Operations
  31




---



##### Table of Contents



Significant Events and Developments
 Events of 2005
 Improvement in Medicare Census.
 Acquisition of ALC.
 (in thousands)ASSETS:Cash, net of cash used to finance the acquisition
    
    $
    (22,652
    )Accounts receivable
    
    
    3,003Other current assets
    
    
    8,308Total current assets
    
    
    (11,341
    )Property, plant and equipment
    
    
    284,223Resident relationships intangible
    
    
    6,357Goodwill
    
    
    2,529Other long-term assets
    
    
    6,016Total assets
    
    $
    287,784LIABILITIES:Current maturities of long-term debt
    
    $
    3,418Other current liabilities
    
    
    19,850Total current liabilities
    
    
    23,268Long-term debt:Long-term debt of ALC assumed
    
    
    141,046Proceeds from 6% from EHI Term Loan to finance acquisition
    
    
    55,000Proceeds from revolving credit facility to finance acquisition
    
    
    60,000Total long-term debt
    
    
    256,046Other long term liabilities
    
    
    8,470Total liabilities
    
    $
    287,784
 32




---



##### Table of Contents



Amendment to Lease Agreement and Option to Purchase.
 33




---



##### Table of Contents



Acquisition and New Developments.
  Medicaid Rates.
  Loan Repayments.
 Impairment of Lakeside Property.
 Divestitures.
 34




---



##### Table of Contents



Events subsequent to June 30, 2005
 Medicare Revenues.
 Amended and Restated Credit Facility.
 
    
    the credit extended to us under the Amended and Restated Credit Facility includes a
term loan for $86.0 million. The principal balance of the term loan is payable in equal
quarterly installments of $215,000 over the first four years of the Amended and Restated
Credit Facility, equal quarterly installments of $20.6 million over the first three
quarters of the last year of the Amended and Restated Credit Facility, and a final principal
installment of $20.6 million due on the maturity date.
    
    the revolving credit limit under the Amended and Restated Credit Facility reflects a
reduction by $41.0 million from the $155.0 million limit under the Revolving Credit Facility
to $114.0 million under the Amended and Restated Credit Facility. Upon notice and at the
option of the participating lenders, we may increase the credit extended or available under
the Amended and Restated Credit Facility by up to $15.0 million. The increase may be in the
form of additional term loans or in the form of an increase in the revolving credit limit.
    
    the maturity date of the Amended and Restated Credit Facility is July 31, 2010,
reflecting an extension of more than one year from the maturity date of the Revolving Credit
Facility.
    
    the interest rate spreads over the Eurodollar rate or the base rate, as applicable,
have been reduced and fixed at 1.75% per annum for Eurodollar rate loans and 0.75% per annum
for base rate loans. Under the Revolving Credit Facility the interest rate spread ranged
from 2.50% per annum to 3.25% per annum for Eurodollar rate loans and from 1.50% per annum
to 2.25% per annum for base rate loans, subject, in each case, to adjustments based on our
senior leverage ratio.
    
    the Amended and Restated Credit Facility includes a $10.0 million swing line
commitment within the $114 million revolving credit limit.
    
    the financial covenants under the Amended and Restated Credit Facility include ALCs
debt and earnings, whereas the financial covenants under the Revolving Credit Facility did
not. The financial covenants are otherwise substantially the same as under the Revolving
Credit Facility;
    
    the Amended and Restated Credit Facility includes procedures for ALC and its
subsidiaries to be designated as restricted subsidiaries and guarantors of the Amended and
Restated Credit Facility over time. As this occurs, these subsidiaries will become subject
to the covenants of the Amended and Restated Credit Facility that apply to our restricted
subsidiaries. Also, we are be permitted to make investments in these subsidiaries to the
same extent that it is permitted to make investments in its other restricted subsidiaries
that have guaranteed the Amended and Restated Credit Facility.
 35




---



##### Table of Contents




    
    the Amended and Restated Credit Facility increases the our ability to make
investments in unrestricted subsidiaries (the unrestricted subsidiaries being ALC and its
subsidiaries unless and until they have been designated as restricted subsidiaries) such
that we and our restricted subsidiaries may have investments in unrestricted subsidiaries
outstanding from time to time up to the sum of the amount of investments in unrestricted
subsidiaries at June 30, 2005 plus $40 million.
    
    the Amended and Restated Credit Facility requires that ALCs debt in connection with
the $22.0 million of Revenue Bonds secured by ALC facilities located in the States of
Washington, Idaho and Ohio be repaid in full within 180 days after the closing of the
Amended and Restated Credit Facility. When that repayment occurs, ALC will become a
restricted subsidiary under the Amended and Restated Credit Facility.
    
    the Amended and Restated Credit Facility increases our ability to make restricted
payments to permit annual dividends up to the lesser of (i) 50% of net income, or (ii) $25
million plus the unused restricted payment amount for the previous fiscal year, or (iii) $50
million.
   New Developments.
 Potential Divestiture.
 Events prior to 2005
 Improvement in Medicare and Total Census.
 Acquisitions of Nursing Facilities.
 Construction Projects
 36




---



##### Table of Contents



Tender Offer/Redemption of 2007 Notes and Sale and Issuance of 2014 Notes.
 Amendment and Restatement of Revolving Credit Facility.
 
    
    a two year maturity extension to June 28, 2009;
    
    an additional $50.0 million of senior secured financing on a revolving basis,
resulting in total borrowing capacity of $155.0 million;
    
    an interest rate spread which ranges from the Eurodollar rate plus 2.50% per annum
to 3.25% per annum or the base rate plus 1.50% per annum to 2.25% per annum, subject, in
each case, to adjustments based on our senior leverage ratio;
    
    a commitment fee of 0.50% per annum on the undrawn capacity regardless of
utilization;
    
    changes to the collateral securing the facility to permit us to substitute certain
assets with other assets.
 Prepayment of Tandem Notes Receivable.
 Completion of Greystone Divestiture Agreement.
 Settlement of Medicare Receivable Issues.
 Divestitures.
 Management and Consulting Services.
 Income Tax Benefits.
 37




---



##### Table of Contents



Key Performance Indicators
  Census
  Average Daily Census
  Occupancy Percentage
  Quality Mix
  Average Revenue Rate by Payor Source
  EBITDA and EBITDA Percentage
  38




---



##### Table of Contents



Review of Key Performance Indicators
  Nursing Facilities  ADC and Quality Mix
  All Nursing Facilities
    
    Three Months
    
    Six MonthsEnded June 30,
    
    Ended June 30,2005
    
    2004
    
    2005
    
    2004Medicare
    
    
    2,477
    
    
    
    2,131
    
    
    
    2,472
    
    
    
    2,178Private and other
    
    
    1,974
    
    
    
    2,227
    
    
    
    2,003
    
    
    
    2,203Quality Mix
    
    
    4,451
    
    
    
    4,358
    
    
    
    4,475
    
    
    
    4,381Medicaid
    
    
    8,580
    
    
    
    8,711
    
    
    
    8,614
    
    
    
    8,642Total
    
    
    13,031
    
    
    
    13,069
    
    
    
    13,089
    
    
    
    13,023
  Nursing FacilitiesSame-Facility
    
    Three Months Ended June 30,2005
    
    2004
    
    % Change% of
    
    
    
    
    
    % of
    
    2005 toADC
    
    Total
    
    ADC
    
    Total
    
    2004Medicare
    
    
    2,437
    
    
    
    19.1
    %
    
    
    2,093
    
    
    
    16.6
    %
    
    
    16.4
    %Private and other
    
    
    1,951
    
    
    
    15.2
    %
    
    
    2,114
    
    
    
    16.7
    %
    
    
    (7.7
    %)Quality Mix
    
    
    4,388
    
    
    
    34.3
    %
    
    
    4,207
    
    
    
    33.3
    %
    
    
    4.3
    %Medicaid
    
    
    8,409
    
    
    
    65.7
    %
    
    
    8,435
    
    
    
    66.7
    %
    
    
    (0.3
    %)Total
    
    
    12,797
    
    
    
    100.0
    %
    
    
    12,642
    
    
    
    100.0
    %
    
    
    1.2
    %
 Six Months Ended June 30,2005
    
    2004
    
    % Change% of
    
    
    
    
    
    % of
    
    2005 toADC
    
    Total
    
    ADC
    
    Total
    
    2004Medicare
    
    
    2,435
    
    
    
    18.9
    %
    
    
    2,132
    
    
    
    16.9
    %
    
    
    14.2
    %Private and other
    
    
    1,984
    
    
    
    15.4
    %
    
    
    2,112
    
    
    
    16.7
    %
    
    
    (7.6
    %)Quality Mix
    
    
    4,419
    
    
    
    34.3
    %
    
    
    4,244
    
    
    
    33.6
    %
    
    
    3.4
    %Medicaid
    
    
    8,455
    
    
    
    65.7
    %
    
    
    8,375
    
    
    
    66.4
    %
    
    
    1.0
    %Total
    
    
    12,874
    
    
    
    100.0
    %
    
    
    12,619
    
    
    
    100.0
    %
    
    
    2.0
    %
  39




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##### Table of Contents



Assisted Living Facilities  ADC and Quality Mix
  All Assisted Living
    
    Three Months
    
    Six MonthsFacilities
    
    Ended June 30,
    
    Ended June 30,2005
    
    2004
    
    2005
    
    2004Private and other
    
    
    5,318
    
    
    
    1,335
    
    
    
    4,627
    
    
    
    1,334Medicaid
    
    
    2,165
    
    
    
    160
    
    
    
    1,814
    
    
    
    157Total
    
    
    7,483
    
    
    
    1,495
    
    
    
    6,441
    
    
    
    1,491
   Assisted Living
    
    Three Months Ended June 30,Same-Facility
    
    2005
    
    2004
    
    % Change% of
    
    
    
    
    
    % of
    
    2005 toADC
    
    Total
    
    ADC
    
    Total
    
    2004Private and other
    
    
    1,168
    
    
    
    87.1
    %
    
    
    1,162
    
    
    
    87.9
    %
    
    
    0.6
    %Medicaid
    
    
    173
    
    
    
    12.9
    %
    
    
    160
    
    
    
    12.1
    %
    
    
    8.1
    %Total
    
    
    1,341
    
    
    
    100.0
    %
    
    
    1,322
    
    
    
    100.0
    %
    
    
    0.5
    %
 Six Months Ended June 30,2005
    
    2004
    
    % Change% of
    
    
    
    
    
    % of
    
    2005 toADC
    
    Total
    
    ADC
    
    Total
    
    2004Private and other
    
    
    1,152
    
    
    
    86.7
    %
    
    
    1,168
    
    
    
    88.2
    %
    
    
    (1.4
    %)Medicaid
    
    
    177
    
    
    
    13.3
    %
    
    
    157
    
    
    
    11.8
    %
    
    
    12.9
    %Total
    
    
    1,329
    
    
    
    100.0
    %
    
    
    1,325
    
    
    
    100.0
    %
    
    
    0.3
    %
 40




---



##### Table of Contents



All Nursing and Assisted Living Facilities  Occupancy and Number of Facilities Under Operation
  All Facilities:
  Three Months Ended June 30All Facilities
    
    Occupancy
    
    
    
    
    
    
    
    
    
    Operational ResidentPercentage
    
    ADC
    
    Capacity2005
    
    2004
    
    2005
    
    2004
    
    2005
    
    2004Nursing
    
    
    92.5
    %
    
    
    91.4
    %
    
    
    13,031
    
    
    
    13,069
    
    
    
    14,090
    
    
    
    14,293Assisted Living:Mature facilities
    
    
    85.5
    %
    
    
    86.3
    %
    
    
    1,080
    
    
    
    1,250
    
    
    
    1,263
    
    
    
    1,449Developmental facilities
    
    
    67.7
    %
    
    
    79.5
    %
    
    
    286
    
    
    
    245
    
    
    
    423
    
    
    
    308ALC acquisition (all mature)
    
    
    89.3
    %
    
    
    
    
    
    
    6,117
    
    
    
    
    
    
    
    6,850
    
    
    
    Total Assisted Living
    
    
    87.7
    %
    
    
    85.1
    %
    
    
    7,483
    
    
    
    1,495
    
    
    
    8,536
    
    
    
    1,757Nursing and Assisted Living
    
    
    90.7
    %
    
    
    90.7.
    %
    
    
    20,514
    
    
    
    14,564
    
    
    
    22,626
    
    
    
    16,050
   Six Months Ended June 30All Facilities
    
    Occupancy
    
    
    
    
    
    
    
    
    
    Operational ResidentPercentage
    
    ADC
    
    Capacity2005
    
    2004
    
    2005
    
    2004
    
    2005
    
    2004Nursing
    
    
    93.0
    %
    
    
    91.4
    %
    
    
    13,089
    
    
    
    13,023
    
    
    
    14,074
    
    
    
    14,254Assisted Living:Mature facilities
    
    
    85.3
    %
    
    
    86.1
    %
    
    
    1,077
    
    
    
    1,250
    
    
    
    1,263
    
    
    
    1,453Developmental facilities
    
    
    72.6
    %
    
    
    85.0
    %
    
    
    276
    
    
    
    241
    
    
    
    379
    
    
    
    284ALC acquisition (all mature)
    
    
    89.6
    %
    
    
    
    
    
    
    5,088
    
    
    
    
    
    
    
    5,677
    
    
    
    Total Assisted Living
    
    
    88.0
    %
    
    
    85.9
    %
    
    
    6,441
    
    
    
    1,491
    
    
    
    7,319
    
    
    
    1,737Nursing and Assisted Living
    
    
    91.3
    %
    
    
    90.8
    %
    
    
    19,530
    
    
    
    14,514
    
    
    
    21,393
    
    
    
    15,991
    41




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##### Table of Contents



Same Facility Basis:
  Three Months Ended June 30
    
    Occupancy
    
    
    
    
    
    
    
    
    
    Operational ResidentSame-Facility Basis
    
    Percentage
    
    ADC
    
    Capacity2005
    
    2004
    
    2005
    
    2004
    
    2005
    
    2004Nursing
    
    
    92.7
    %
    
    
    91.8
    %
    
    
    12,797
    
    
    
    12,642
    
    
    
    13,802
    
    
    
    13,776Assisted Living:Mature facilities
    
    
    85.5
    %
    
    
    85.3
    %
    
    
    1,080
    
    
    
    1,081
    
    
    
    1,263
    
    
    
    1,268Developmental facilities
    
    
    74.6
    %
    
    
    85.5
    %
    
    
    261
    
    
    
    241
    
    
    
    351
    
    
    
    281Total Assisted Living
    
    
    83.1
    %
    
    
    85.3
    %
    
    
    1,341
    
    
    
    1,322
    
    
    
    1,614
    
    
    
    1,549Nursing and Assisted Living
    
    
    91.7
    %
    
    
    91.1
    %
    
    
    14,138
    
    
    
    13,964
    
    
    
    15,416
    
    
    
    15,325
  Six Months Ended June 30
    
    Occupancy
    
    
    
    
    
    
    
    
    
    Operational ResidentSame-Facility Basis
    
    Percentage
    
    ADC
    
    Capacity2005
    
    2004
    
    2005
    
    2004
    
    2005
    
    2004Nursing
    
    
    93.2
    %
    
    
    91.6
    %
    
    
    12,874
    
    
    
    12,619
    
    
    
    13,807
    
    
    
    13,780Assisted Living:Mature facilities
    
    
    85.3
    %
    
    
    85.4
    %
    
    
    1,078
    
    
    
    1,086
    
    
    
    1,263
    
    
    
    1,271Developmental facilities
    
    
    77.7
    %
    
    
    88.4
    %
    
    
    251
    
    
    
    239
    
    
    
    323
    
    
    
    271Total Assisted Living
    
    
    83.8
    %
    
    
    85.9
    %
    
    
    1,329
    
    
    
    1,325
    
    
    
    1,586
    
    
    
    1,542Nursing and Assisted Living
    
    
    92.3
    %
    
    
    91.0
    %
    
    
    14,203
    
    
    
    13,944
    
    
    
    15,393
    
    
    
    15,322
  42




---



##### Table of Contents



Facilities Under Operation and Percent Ownership:
  As of
    
    As ofJune 30,
    
    December 31,2005
    
    2004Number of facilities under operation:Nursing
    
    
    141
    
    
    
    141Assisted Living
    
    
    210
    
    
    
    32Total
    
    
    351
    
    
    
    173Number of facilities owned:Nursing
    
    
    132
    
    
    
    132Assisted Living
    
    
    154
    
    
    
    31Total
    
    
    286
    
    
    
    163Number of facilities under capital leases:Assisted Living
    
    
    5
    
    
    
    Percent of facilities:
Owned
    
    
    81.5
    %
    
    
    94.2
    %Under capital leases
    
    
    1.4
    %
    
    
    Under operating leases
    
    
    17.1
    %
    
    
    5.8
    %100.0
    %
    
    
    100.0
    %
  Nursing Facilities  Average Revenue per Resident Day by Payor Source
  All Nursing Facilities
    
    Three Months
    
    Six MonthsEnded June 30,
    
    Ended June 30,2005
    
    2004
    
    Change
    
    2005
    
    2004
    
    ChangeMedicare (Part A and Part B)
    
    $
    371.48
    
    
    $
    357.65
    
    
    
    3.9
    %
    
    $
    371.08
    
    
    $
    352.12
    
    
    
    5.4
    %Private and other
    
    $
    199.22
    
    
    $
    189.68
    
    
    
    5.0
    %
    
    $
    197.90
    
    
    $
    191.20
    
    
    
    3.5
    %Medicaid
    
    $
    147.87
    
    
    $
    136.31
    
    
    
    8.5
    %
    
    $
    147.77
    
    
    $
    135.35
    
    
    
    9.2
    %Total
    
    $
    198.16
    
    
    $
    181.50
    
    
    
    9.2
    %
    
    $
    197.61
    
    
    $
    181.05
    
    
    
    9.2
    %Medicare Part A only
    
    $
    342.18
    
    
    $
    324.50
    
    
    
    5.4
    %
    
    $
    341.17
    
    
    $
    321.17
    
    
    
    6.2
    %
  43




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##### Table of Contents



Assisted Living Facilities  Average Revenue per Resident Day by Payor Source
  All
Assisted Living
    
    Three Months
    
    Six MonthsFacilities
    
    Ended June 30,
    
    Ended June 30,2005
    
    2004
    
    Change
    
    2005
    
    2004
    
    ChangePrivate and other
    
    $
    91.09
    
    
    $
    74.20
    
    
    
    22.8
    %
    
    $
    88.75
    
    
    $
    74.38
    
    
    
    19.3
    %Medicaid
    
    $
    61.64
    
    
    $
    53.29
    
    
    

    15.7
    %
    
    $
    61.88
    
    
    $
    52.87
    
    
    
    17.0
    %Total
    
    $
    82.57
    
    
    $
    71.96
    
    
    
    14.7
    %
    
    $
    81.18
    
    
    $
    72.12
    
    
    
    12.6
    %
  EBITDA and EBITDA Percentage
  Three Months
    
    Six MonthsEnded June 30,
    
    Ended June 30,2005
    
    2004
    
    2005
    
    2004(in thousands)Income before income taxes
    
    $
    24,980
    
    
    $
    14,123
    
    
    $
    44,874
    
    
    $
    29,109Add (deduct):Depreciation and amortization
    
    
    12,267
    
    
    
    8,831
    
    
    
    22,607
    
    
    
    17,512Interest expense, net
    
    
    9,868
    
    
    
    4,384
    
    
    
    18,012
    
    
    
    10,969Valuation adjustment on interest rate caps
    
    
    939
    
    
    
    4,320
    
    
    
    2,237
    
    
    
    4,393Loss (gain) on disposal of assets and
impairment of long-lived assets
    
    
    5,070
    
    
    
    (4,469
    )
    
    
    4,622
    
    
    
    (2,857
    )Loss on refinancing and retirement of debt
    
    
    
    
    
    
    5,978
    
    
    
    275
    
    
    
    6,332EBITDA
    
    $
    53,124
    
    
    $
    33,167
    
    
    $
    92,627
    
    
    $
    65,458
  Three Months
    
    Six MonthsEnded June 30,
    
    Ended June 30,2005
    
    2004
    
    2005
    
    2004(in thousands)EBITDA
    
    $
    53,124
    
    
    $
    33,167
    
    
    $
    92,627
    
    
    $
    65,458Total Revenues
    
    $
    312,348
    
    
    $
    233,328
    
    
    $
    606,495
    
    
    $
    464,829EBITDA as percentage of total revenues
    
    
    17.0
    %
    
    
    14.2
    %
    
    
    15.3
    %
    
    
    14.1
    %
  44




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##### Table of Contents



Results from Operations
  Three Months
    
    Six MonthsEnded June 30,
    
    Ended June 30,2005
    
    2004
    
    2005
    
    2004RevenuesNursing and assisted living facilities
    
    
    97.5
    %
    
    
    96.7
    %
    
    
    97.4
    %
    
    
    96.8
    %Outpatient therapy
    
    
    0.9
    
    
    
    1.3
    
    
    
    0.9
    
    
    
    1.2Other
    
    
    1.6
    
    
    
    2.0
    
    
    
    1.7
    
    
    
    2.0100.0
    
    
    
    100.0
    
    
    
    100.0
    
    
    
    100.0Operating and general and administrative costs
    
    
    81.1
    
    
    
    84.8
    
    
    
    83.0
    
    
    
    84.9Lease costs, depreciation and amortization
    
    
    5.8
    
    
    
    4.7
    
    
    
    5.4
    
    
    
    4.7Interest expense, net
    
    
    3.2
    
    
    
    1.9
    
    
    
    3.0
    
    
    
    2.4Valuation adjustment on interest rate cap
    
    
    0.3
    
    
    
    1.8
    
    
    
    0.4
    
    
    
    0.9Loss (gain) on disposal of assets and impairment of long-lived assets
    
    
    1.6
    
    
    
    (1.9
    )
    
    
    0.7
    
    
    
    (0.6
    )Loss on refinancing and retirement of debt
    
    
    0.0
    
    
    
    2.6
    
    
    
    0.1
    
    
    
    1.4Income before income taxes
    
    
    8.0
    
    
    
    6.1
    
    
    
    7.4
    
    
    
    6.3Income tax expense
    
    
    3.1
    
    
    
    2.3
    
    
    
    2.9
    
    
    
    2.4Net income
    
    
    4.9
    %
    
    
    3.8
    %
    
    
    4.5
    %
    
    
    3.9
    %
 2005 June Quarter Compared with 2004 June Quarter
 Revenues
  45




---



##### Table of Contents



(in Millions) Indiana and Pennsylvania Medicaid revenues in the 2005 June quarter attributable to the
approval of the state plan amendments and waivers (the related increase in state assessment expense
of $3.3 million is reflected in operating expenses below)
    
    $
    4.5 Indiana Medicaid revenues in the 2005 June quarter attributable to the 2005 March quarter due to
the approval of state plan amendments and waivers (the related increase in state assessment expense
of $1.3 million is reflected in operating expenses below)
    
    
    2.2 Medicare census increasing from 16.5% of total in the 2004 June quarter to 19.1% in the 2005 June
quarter
    
    
    5.3 average daily nursing Medicaid rates, in states other than Indiana and Pennsylvania
    
    
    4.0 Medicare revenues due to the 2.8% Medicare Part A rate increase effective October 1, 2004
    
    
    2.0 total census increasing from 12,642 ADC in the 2004 June quarter to 12,797 in the 2005 June quarter
    
    
    1.9 Medicare revenues due to the improvement in RUGs mix and other factors
    
    
    1.8 private and other nursing rates
    
    
    1.3 assisted living revenues
    
    
    0.4 nursing ancillary revenues
    
    
    0.323.7Adjustments relating to prior years: Indiana Medicaid revenues in the 2005 June quarter attributable to the approval of the state plan
amendment and waiver for the period July 1, 2003 through December 31, 2004 (the related increase in
state assessment expense of $6.3 million is reflected in operating expenses below)
    
    
    11.0 Other prior year settlement adjustments in the 2005 June quarter as compared to 2004 June quarter
    
    
    (0.6
    )Total increase in revenues from same facility nursing and assisted living facilities
    
    $
    34.1
 Operating and General and Administrative Costs
  46




---



##### Table of Contents



(in Millions) wages, benefits and contracted staffing, which included an average wage rate increase of 1.4%
    
    $
    9.8 state assessment taxes in Indiana and Pennsylvania for 2005 June quarter attributable to the
approval of the state plan amendments and waivers
    
    
    3.3 state assessment taxes in Indiana for 2005 March quarter relating to final approval of the state
plan amendments and waivers
    
    
    1.3 drug expense due to higher Medicare mix, resident acuity and drug prices
    
    
    1.3 medical equipment leases and supply costs
    
    
    0.9 bad debts expense
    
    
    0.6 other state assessments and bed taxes
    
    
    0.4 other operating and administrative expenses
    
    
    2.119.7Adjustment relating to prior year: state assessment taxes in Indiana in the 2005 June quarter attributable to the approval of the
state plan amendment and waiver for the period July 1, 2003 through December 31, 2004
    
    
    6.3Total increase in same facility operating and general and administrative costs
    
    $
    26.0
 Lease Costs, Depreciation and Amortization
  Interest Expense, Net
   Valuation Adjustment on Interest Rate Caps
  Loss (Gain) on Disposal of Assets and Impairment of Long-Lived Assets
  47




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##### Table of Contents



Loss on Refinancing and Retirement of Debt
   Income Taxes
  Net Income
  Related Party Transactions
   Six Months Ended June 30, 2005 Compared with Six Months Ended June 30, 2004
 Revenues
  48




---



##### Table of Contents



(in Millions) Indiana and Pennsylvania Medicaid revenues attributable to the approval of the state plan
amendments and waivers (the related increase in state assessment expense of $6.8 million is
reflected in operating expenses below)
    
    $
    9.1 average daily nursing Medicaid rates, in states other than Indiana and Pennsylvania
    
    
    9.5 Medicare census increasing from 16.9% of total in the 2004 period to 18.9% in the 2005 period
    
    
    9.2 total census increasing from 12,619 in the 2004 June period to 12,874 in the 2005 June period
    
    
    6.4 Medicare revenues due to the 2.8% Medicare Part A rate increase effective October 1, 2004
    
    
    4.0 Medicare revenues due to the improvement in RUGs mix and other factors
    
    
    3.9 an increase in private and other nursing rates
    
    
    2.4 nursing ancillary revenues
    
    
    1.3 nursing revenues due to one less day in the 2005 June period compared to the 2004 June period
    
    
    (2.3
    ) an increase in assisted living revenues
    
    
    0.544.0Adjustments relating to prior years: Indiana and Pennsylvania Medicaid revenues in the 2005 June period attributable to the approval
of the state plan amendments and waivers for the period July 1, 2003 through December 31, 2004 (the
related increase in state assessment expense of $19.6 million is reflected in operating expenses
below)
    
    
    27.4 Other prior year settlement adjustments in the 2005 June period as compared to the 2004 June period
    
    
    (1.3
    )Total increase in revenues from same facility nursing and assisted living facilities
    
    $
    70.1
 Operating and General and Administrative Costs
  49




---



##### Table of Contents



(in Millions) wages, benefits and contracted staffing, which included an average wage rate increase of 1.3%
    
    $
    22.2 state assessment taxes in Indiana and Pennsylvania for 2005 June period attributable to the
approval of the state plan amendments and waivers
    
    
    6.8 other state assessments and bed taxes
    
    
    1.7 drug expense due to higher resident census, resident acuity and drug prices
    
    
    2.7 medical equipment lease, food and supplies expense
    
    
    2.1 repairs and maintenance, utilities and telephone
    
    
    1.5 professional fees, fines and penalties
    
    
    1.0 other operating and administrative expenses
    
    
    1.739.7Adjustment relating to prior year: state assessment taxes in Indiana and Pennsylvania for the period July 1, 2003 through December
31, 2004 due to final approval of the state plan amendments and waivers
    
    
    19.6Total increase in same facility operating and general and administrative costs
    
    $
    59.3
 Lease Costs, Depreciation and Amortization
  Interest Expense, Net
   Valuation Adjustment on Interest Rate Caps
  Loss (Gain) on Disposal of Assets and Impairment of Long-Lived Assets
  50




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##### Table of Contents



Loss on Refinancing and Retirement of Debt
   Income Taxes
  Net Income
  Related Party Transactions
   51




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##### Table of Contents



June 30,
    
    December 31,Affiliate
    
    Purpose
    
    2005
    
    2004(in thousands)Receivable (payable)Current assets:Extendicare Holdings, Inc.
    
    Federal income taxes
receivable
    
    $
    7,062
    
    
    $
    5,231Extendicare Holdings, Inc.
    
    Deferred federal income
taxes
    
    
    14,600
    
    
    
    13,258Extendicare Inc.
    
    Working capital advances
    
    
    3⁄4
    
    
    
    7,69021,662
    
    
    
    26,179Current liabilities:Virtual Care Provider, Inc.
    
    Working capital advances
    
    
    (3,000
    )
    
    
    (3,000
    )The Northern Group, Inc.
    
    Intercompany operating
expenses
    
    
    17
    
    
    
    19Laurier Indemnity Company
    
    Intercompany insurance
premium
    
    
    6
    
    
    
    3Extendicare Holdings, Inc.
    
    Working capital advances
    
    
    3
    
    
    
    3(2,974
    )
    
    
    (2,975
    )Long-term liabilities:Extendicare Holdings, Inc.
    
    Deferred federal income
taxes
    
    
    (6,914
    )
    
    
    (1,853
    )Other:Extendicare Inc.
    
    Advances
    
    
    3⁄4
    
    
    
    (8,900
    )Extendicare Inc.
    
    Advances
    
    
    2,300
    
    
    
    1,218Extendicare Holdings, Inc.
    
    Advances
    
    
    (3,483
    )
    
    
    (3,483
    )Virtual Care Provider, Inc.
    
    Advances
    
    
    (3,796
    )
    
    
    (3,620
    )(4,979
    )
    
    
    (14,785
    )$
    6,795
    
    
    $
    6,566
   52




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##### Table of Contents



Liquidity and Capital Resources
 Sources and Uses of Cash
  Six MonthsEnded June 30,2005
    
    2004(in thousands)Cash provided by operating activities
    
    $
    51,349
    
    
    $
    51,639Cash provided by (used in) investing activities
    
    
    (168,538
    )
    
    
    10,073Cash provided by (used in) financing activities
    
    
    97,506
    
    
    
    (81,096
    )Decrease in cash and cash equivalents
    
    
    (19,683
    )
    
    
    (19,384
    )
      53




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##### Table of Contents



54




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##### Table of Contents



Debt Instruments
 Summary of Long-term Debt
  June 30,
    
    December 312005
    
    2004(in thousands)9.50% Senior Notes due 2010
    
    $
    149,734
    
    
    $
    149,7146.875% Senior Subordinated Notes due 2014
    
    
    122,137
    
    
    
    122,022Revolving Credit Facility due 2009, at variable
interest rates
    
    
    62,000
    
    
    
    6.00% EHI Term Note due 2010
    
    
    55,000
    
    
    
    6.24% Red Mortgage Capital Note due 2014
    
    
    36,858
    
    
    
    GE Capital Term Loan and Credit Facility, at variable interest rates, due 2009
    
    
    35,272
    
    
    
    DMG Mortgage notes payable, interest rates ranging from 7.58% to 8.65%, due 2008
    
    
    27,816
    
    
    
    Revenue Bonds, at variable interest rates, maturing through 2018
    
    
    21,995
    
    
    
    Capital lease obligations, interest rates ranging from 2.84% to 13.54%,
maturing through 2009
    
    
    12,397
    
    
    
    11Oregon Trust Deed Notes, interest rates ranging from 0.25% to 10.90%, maturingfrom 2020 through 2026
    
    
    9,714
    
    
    
    HUD Insured Mortgages, interest rates ranging from 7.40% to 7.55%, due 2036
    
    
    7,709
    
    
    
    6.00% EI Term Note due 2010
    
    
    8,900
    
    
    
    Other mortgage notes payable, interest rates ranging from 3.0% to 7.25%, maturing
through 2009
    
    
    4,202
    
    
    
    9,730Industrial Development Revenue Bond due 2014
    
    
    
    
    
    
    9,5006.25% Industrial Development Revenue Bond, maturing 2008
    
    
    955
    
    
    
    955Long-term debt before current maturities
    
    
    554,689
    
    
    
    291,932Less current maturities
    
    
    5,307
    
    
    
    1,071Total long-term debt
    
    $
    549,382
    
    
    $
    290,861
   9.50% Senior Notes due 2010
  55




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##### Table of Contents



Year
    
    Redemption Price2006
    
    
    104.750
    %2007
    
    
    102.375
    %2008 and thereafter
    
    
    100.000
    %
  6.875% Senior Subordinated Notes due 2014
 .
  56




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##### Table of Contents



Year
    
    Redemption Price2009
    
    
    103.438
    %2010
    
    
    102.292
    %2011
    
    
    101.146
    %2012 and thereafter
    
    
    100.000
    %
 Revolving Credit Facility
       57




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##### Table of Contents



6.0% EHI Term Note due 2010
  6.24% Red Mortgage Capital Note due 2014
  GE Capital Term Loan and Credit Facility due 2009
   DMG Mortgage Notes Payable due 2008
  Revenue Bonds
   58




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##### Table of Contents



Capital Lease Obligations
   Oregon Trust Deed Notes
   HUD Insured Mortgages due 2036
  6.0% EI Term Note due 2010
  Mortgage Notes Payable
  59




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##### Table of Contents



Industrial Development Revenue Bond due 2014
  Credit Ratings
  
    
    Moodys Investors Service assigned a B2 rating to the 2010 Senior Notes.
    
    S&P assigned a B- rating to the 2014 Notes.
    
    S&P assigned a BB- rating to the Revolving Credit Facility.
 Interest Rate Swap and Cap Agreements
     60




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##### Table of Contents



Letters of Credit
  Off Balance Sheet Arrangements
  Cash Management
  Future Liquidity and Capital Resources
   61




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##### Table of Contents



Contractual Obligations
  Payments Due By YearAfterTotal
    
    2005
    
    2006
    
    2007
    
    2008
    
    2009
    
    2009(dollars in thousands)Long-term debt
    
    $
    554,689
    
    
    $
    3,395
    
    
    $
    5,579
    
    
    $
    8,759
    
    
    $
    29,502
    
    
    $
    107,024
    
    
    $
    400,430Operating lease commitments
    
    
    162,187
    
    
    
    10,744
    
    
    
    18,586
    
    
    
    16,651
    
    
    
    16,886
    
    
    
    16,881
    
    
    
    82,439Total
    
    $
    716,876
    
    
    $
    14,139
    
    
    $
    24,165
    
    
    $
    25,410
    
    
    $
    46,388
    
    
    $
    123,905
    
    
    $
    482,869
  Critical Accounting Policies
  62




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##### Table of Contents



Item 3. Quantitative and Qualitative Disclosures About Market Risk
 Qualitative Disclosures
     Quantitative Disclosures
  Maturity Date through December 31,EstimatedFair Value ofLiability2005
    
    2006
    
    2007
    
    2008
    
    2009
    
    Thereafter
    
    Total
    
    (Asset)(dollars in thousands)LONG-TERM DEBT:Fixed Rate
    
    $
    1,774
    
    
    $
    3,291
    
    
    $
    6,257
    
    
    $
    26,823
    
    
    $
    12,091
    
    
    $
    385,186
    
    
    $
    435,422
    
    
    $
    452,496Average Interest Rate
    
    
    5.32
    %
    
    
    5.51
    %
    
    
    6.29
    %
    
    
    4.83
    %
    
    
    6.23
    %
    
    
    7.48
    %
    
    
    7.42
    %Variable Rate
    
    $
    1,621
    
    
    $
    2,288
    
    
    $
    2,502
    
    
    $
    2,680
    
    
    $
    94,933
    
    
    $
    15,243
    
    
    $
    119,267
    
    
    $
    117,541Average Interest Rate
    
    
    3.70
    %
    
    
    4.56
    %
    
    
    4.65
    %
    
    
    4.70
    %
    
    
    6.60
    %
    
    
    2.54
    %
    
    
    5.92
    %INTEREST RATE SWAPS:(fixed to variable)Notional Amount
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    $
    275,000
    
    
    $
    275,000
    
    
    $
    (2,435
    )Average Pay Rate (variable rate)
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    7.14
    %
    
    
    7.14
    %Average Receive Rate (fixed rate)
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    8.31
    %
    
    
    8.31
    %INTEREST RATE CAPS:Notional Amount
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    $
    150,000
    
    
    $
    150,000
    
    
    $
    (284
    )Notional Amount
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    $
    125,000
    
    
    $
    125,000
    
    
    $
    6,306
  63




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##### Table of Contents



Item 4. Controls and Procedures
 Evaluation of Disclosure Controls and Procedures
  Changes in Internal Controls Over Financial Reporting
  64




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##### Table of Contents



PART II
OTHER INFORMATION
 
 Item 1. Legal Proceedings
  
 Item 6. Exhibits
  65




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##### Table of Contents



EXTENDICARE HEALTH SERVICES, INC.
 
 SIGNATURES
   Date: August 11, 2005
    By:
    /s/ Richard L. BertrandRichard L. BertrandSenior Vice President, Chief Financial
Officer and Treasurer and Director
(Principal Accounting Officer) 66




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##### Table of Contents



EXTENDICARE HEALTH SERVICES, INC.
 
 EXHIBIT INDEX
 4.1
    
    Third Amended And Restated Credit Agreement, dated as of August 4, 2005, among
Extendicare Holdings, Inc., Extendicare Health Services, Inc., as Borrower,
the several lenders from time to time parties thereto, Lehman Brothers Inc.,
as Arranger, U.S. Bank, National Association, as Syndication Agent, General
Electric Capital Corporation and LaSalle Bank National Association, as
Co-Documentation Agents and Lehman Commercial Paper Inc., as Administrative
Agent (Incorporated by reference to Exhibit 4.1 to the Companys Current
Report on Form 8-K dated August 4, 2005)31.1
    
    Certifications of Chairman of the Board and Chief Executive Officer.31.2
    
    Certifications of Senior Vice President, Chief Financial Officer and Treasurer.32
    
    Written Statement of Chairman of the Board and Chief Executive Officer and
Senior Vice President, Chief Financial Officer and Treasurer pursuant to 18
U.S.C. Section 1350.
 67